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The non-bank revolution

The Australian lending market has long been dominated by the big four banks, but, in recent years, there has been a remarkable surge in a previously overlooked sector of our financial market: private credit, says Paul Miron, managing director of Msquared Capital.

Non-bank lenders, constituting approximately 5 per cent of Australia’s financial system, have also been experiencing rapid growth, particularly in mortgage lending. This trend indicates a significant shift in borrower preferences and presents a compelling case for brokers to explore the opportunities offered by private credit.

Untapped potential in Australia

Driven primarily by growth in mortgage lending, there is no sign of private credit slowing down. Mortgage lending growth has averaged 15 per cent on a six-month annualised basis — more than twice the rate recorded by banks, according to the RBA. Around 5.37 per cent of housing finance came from private credit in 2022, up from 4.88 per cent in 2021.

Even before the onset of COVID-19, lenders owned by the big banks saw their market share slide from 77 per cent to 67 per cent while non-major lenders increased their market share by 42.4 per cent year on year to $1.77 billion (according to loans.com.au).

However, despite the dominance of private credit funds in the US and Europe, Australia is still in the early stages of embracing this financial instrument. Currently, private credit accounts for only 8 per cent of the market share for all commercial mortgages in Australia while its counterparts in the US and Europe command 70 per cent and 48 per cent, respectively. This discrepancy highlights the need for increased awareness and understanding of private credit funds in Australia, including the benefits, risk-reward relationship, and variety of investment options.

Structural changes and the regulatory environment

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Structural changes in the Australian debt market have paved the way for the rapid growth of private credit. Historically, the big four banks have dominated lending in Australia, but with stricter banking regulations and increased selectivity in borrowers, non-bank lenders have emerged as a viable alternative.

The aftermath of the global financial crisis and the subsequent banking royal commission have eroded public trust in traditional financial institutions, leading borrowers to seek faster loan approvals from non-bank lenders. This shift has allowed private credit to gain traction and establish itself as a competitive player in the lending landscape.

Contrary to scepticism surrounding potential risks, a recent RBA research paper (Non-Bank Lending in Australia and the Implications for Financial Stability) highlighted that non-bank lending standards have not deteriorated despite the strong credit growth between 2020 and mid-2022. In fact, the share of non-bank loans with high LVRs has declined to a level below that of banks, according to the RBA.

Why private credit?

Private credit offers significant benefits to borrowers, particularly those who may face challenges in meeting the strict lending criteria imposed by banks. For these borrowers, private credit serves as an alternative source of finance when their mortgage applications are rejected.

For example, Msquared Capital employs a comprehensive and individualised credit process that evaluates borrowers based on character, capacity, cash flow, collateral, and competency. Rather than hastily rejecting prospective borrowers, we take a thorough approach to assess creditworthiness.

Another advantage of private credit is the speed at which loans can be reviewed, processed, and delivered. Unlike the complex machinery of large banks, private credit providers prioritise efficiency, ensuring that loan applications do not get neglected or forgotten.

The road ahead

The success of private credit in the US and Europe sets a precedent for its future prospects in Australia. Tailored solutions for borrowers, high returns for investors, regulatory favour, and strong growth in recent years all point to a bright future for private credit.

To capitalise on the growing demand for private credit and tap into an underserved market, Msquared Capital has recently entered a joint venture with EG Funds to provide more opportunities for investors to diversify and secure strong returns backed by property.

Under this JV, we will provide new lending products, with the initial focus on lending to luxury residential properties and owner-occupied or rented industrial properties, with up to 75 per cent of the property values with loan amounts up to $50 million on a low documentation basis.

This collaboration opens up new avenues for diversification and offers opportunities for strong risk-mitigated returns.

Paul Miron is the managing director of Msquared Capital

He has over 25 years’ experience in the finance industry and is the principal theorist behind Msquared Capital’s credit policy. He is respected and recognised for his economic views and ability to mitigate risks through well-considered structuring and has facilitated funding for many significant projects predominantly in NSW but also spanning Victoria and Queensland.

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